The Canadian Investor - Making Sense of Canada’s Economy with Richard Dias

Episode Date: September 28, 2023

In this episode, Simon talks with Richard Dias from the Loonie Hour and PGM Global. Richard is a macro expert and we talk about the state of the Canadian economy and where it's heading.  Symbols of stocks discussed:  Check out our portfolio by going to Jointci.com Our Website Canadian Investor Podcast Network Twitter: @cdn_investing Simon’s twitter: @Fiat_Iceberg Braden’s twitter: @BradoCapital Want to learn more about Real Estate Investing? Check out the Canadian Real Estate Investor Podcast! Apple Podcast - The Canadian Real Estate Investor  Spotify - The Canadian Real Estate Investor  Sign up to Stratosphere for free 🚀 our platform for self-directed stock investing research. Register for EQ Bank, the seamless digital banking experience with better rates and no nonsense.See omnystudio.com/listener for privacy information.

Welcome back into the show. This is the Canadian Investor Podcast, made possible by our friends and show sponsor, EQ Bank, which helps Canadians make bank with high interest and no fees on everyday banking. We also love their savings and investment products like GICs, which offer some of the best rates on the market. I personally, and I know Simone as well, is using the GICs, which offer some of the best rates on the market. I personally, and I know Simone as well, is using the GICs on a regular basis to set money aside for personal income taxes in April of every year. Their GICs are perfect because the interest rate is guaranteed, and I know I won't be able to touch that money until I need it for tax time. Whether you're looking to set some money aside for a rainy day or a big purchase is

coming through the pipeline or simply want to lower the risk of your overall investment portfolio, EQ Bank's GICs are a great option. The best thing about EQ Bank is that it is so easy to use. You can open an account and buy a GIC online in minutes. Take advantage of some of the best rates on the market today at eqbank.ca forward slash GIC. Again, eqbank.ca forward slash GIC. This is the Canadian Investor, where you take control of your own portfolio and gain the confidence you need to succeed in the markets. Hosted by Brayden Dennis and Simon Belanger. Welcome back to the Canadian Investor Podcast. I'm here with Richard Diaz. Am I saying your last name correctly? Yeah, Richard Diaz. That's it. Diaz. Okay. Okay. Because I am the French accent, you know, it's always a little bit hard. It's perfect. It's perfect. Thank you for checking,

but no, it's perfect. Thank you. Okay. And for those of you not familiar with Rich, Rich is the co-host, one of the co-hosts, I guess, from the Looney Hour. And it's a fantastic show. If anyone wants to listen and learn more about macro, obviously focuses on Canada, but looks at the whole world as a whole. Because Canada, as much as we like to think we're important, we're just not that important on the global stage. So welcome to the show. Do you want to give us a little introduction, what you do outside the podcast as well? Yeah, sure. So I'm a global strategist, which is kind of an all-encompassing sort of classically finance terminology for saying a lot, saying very little with a lot. But really what I do is I look at the world from a top-down perspective and I help institutional investors identify risks and identify opportunities in the financial markets, specifically public ones. So that

includes stocks and bonds and equities. Sorry, sorry, I find out FX, so foreign exchange, as well as currency. And I've done that basically forever. And it's something I'm really passionate about. And I really love doing it, really. So hopefully that comes across in this interview and the rest of my work. No, I think it shows that you're really passionate about it. And obviously, you know, we're Canada, more Canada focused. Just give you context. I think our listeners, it's wide ranging.

Some people may know quite a bit about macro, some not a lot. And the investment knowledge is all over the place. And then I'm just going to double click in terms of institutional investors, just so people know, like what kind of what's an institutional investor? Like I know, but just for kind of, what's an institutional investor? Like, I know, but just for... No, that's absolutely right. And I'll maybe, and at the same time, maybe I'll just sort of elaborate more on what I mean by macro. So an institutional, there are retail investors, which is, you know, a mom and pop with sort of a Questrade account, or, you know, a TD, sort of self-directed TFSA, that kind of thing. And then there's institutions. And what that broadly means is sort of more sophisticated investors generally, although there are some

unsophisticated institutional investors. And basically, those are the people who are effectively paid to do it. So professionals, professionals, investors. They're normally quite heavily regulated. They normally are part of a charter either a cfa or otherwise or i think in canada we have the securities exchange commission that you have to be sort of vetted and approved by but most the most important thing is that you're basically professional and you usually nearly always do that on behalf of someone else so things like a fiduciary duty or a duty of care is very, very important and taken very seriously. And so that's what I would mean by institutional investor.

So I think people listening would probably understand things like, you know, the Ontario Teachers Pension Fund might be one example. Or CalPERS, you know, the California Teachers Pension Fund or Texas. But it's not just teachers and pension funds. It could be a hedge fund. So, you know, Bridgewater is a very famous hedge fund. I mean, they're not a client of ours, but that would be, so it's a very, very big pool of money

and they're allowed to invest in all sorts of weird and wonderful things. Have you ever read Dalio or not yet? No, no, no. No, I'm not big time. Sadly, maybe one day. And then the other aspect of that is sort of there's also high net worth individuals.

So you might have either a family or an individual with a huge pool of money, and they often hire people to manage those funds for themselves and their family and for generational wealth. And maybe just, Simon, if I could just touch on what macro means, sorry, because I just sort of skipped over that. Macro means looking at the world through a lens of economic data, particularly sort of broader economic data. So that means that might be sort of GDP, so the growth and productivity of a country. You might look at inflation and the monetary policy that sort of comes from that. and the monetary policy that sort of comes from that. You'll look at things like unemployment, labor markets, and how they affect margins or how certain sectors do. You might look at things like energy, again, from a top down. So what that means is from like sort of from very high level

sort of perspective, the opposite to that. so people are wondering, is sort of a bottom-up approach. And that would be someone who looks at a very specific stock and knows everything there is to know about a particular stock or two or many stocks or what have you. So for example, they'll understand everything there is to know about, let's say, Canadian tire, how their margins are doing, how their business is doing, how many stores they're opening. Are they hiring and firing employees? What's the compensation for the CEO? That would be sort of a bottom-up perspective. And top-down, which is what I do, is, like I said, GDP, money supply, etc.

Okay. No, that's great. And I guess double-clicking on Canadian Tire, because we've talked about it quite a bit on the show. Oh, have you? Sorry, I didn't know that. Oh, no, that's fine. And I also talked about CNRail, which earlier in the spring, they had flagged that I think their consumer goods freight, like demand for consumer goods had actually slowed down. And then after that, Canadian Tire came, and I was saying, looking at just earnings from businesses, at least in Canada, these are, in my opinion, bellwether stocks for the Canadian economy. Yeah, especially Canadian Tire,

which has all this financial data on consumers with their credit card business. And I think it's an important warning that definitely what's going on with the Canadian economy. So I know you love GDP per capita. I know you're not a fan of GDP. Do you want to explain to us why it's such a good metric? I think you explained it quite well. And you know what, is there a country that Canada can be compared to? I was kind of debating that mentally. I'm like, maybe Australia has some similarities. But again, anyways, I'll let you go on that. But that's kind of where I was going with that question. Yeah, sure.

That's great. So GDP is, broadly speaking, GDP is how you calculate the productive output of an economy. productive output of an economy. Now, that is a very difficult task, which is mostly a thankless task done by very smart statisticians and economists. But basically, the way that you can think about it, there's different ways. There's something called a production approach, where you look at the sort of gross value added, there's sort of that there's like an income approach, which is how much like wealth specifically a country can generate. But the way I think is probably the easiest way to think about GDP is to think about sort of the expenditure approach, which is the one I sort of focus on,

because the data is easier to get, frankly. And it's easier, it's more intuitive, I would argue, although there are some people who might disagree with that. And what that means is the expenditure approach. So what basically is, what is spent in a particular economy? Now, it doesn't have to be an economy, it can be a region, but let's just use a country, for example. And there's different ways to categorize that spending. And so there's consumption. So let's just say broad strokes, what households spend, what investment.

So there could be different types of investment. It could be non-residential investment. It could be residential investment. It could be structures and equipment and intellectual property would be included in that. Then there's government spending, all types of government spending. So on services, consumption, investment, have you. And then there's sort of a net export component. So sort of your exports minus your imports. And that, you know, C plus I plus G plus net exports equals Y is what we learn in school.

And that is sort of the productive output of an economy or what we call gdp yeah and is consumer spend am i correct is it like about two-thirds of gdp is that around okay yeah for canada it is for the u.s for example it's probably closer to 75 okay um and there are countries that are much much lower than that for example china's economy is very much more dependent on exports still even though they are trying to shift away from that and so the export part would be much much larger um but yeah so you know it varies depending on sort of how sophisticated your economy is how rich your economy is and how many how if the economy is, how rich your economy is, and how many, how, if the economy is basically, you know,

dependent on more goods or services or what have you. Okay. And in terms of comparing to a country, because I know, you know, our government likes to reference the G7 or even sometimes the G20, and they kind of pick and choose what data they want to look at. And, you know, all like, we're kind of, we try not to get into politics. I'm, you know, I'll be critical of any, you know, party. I'm not very, you know, I'm not assigned to any kind of political affiliation myself. But yeah, what country should we, in your opinion, that's kind of best to try and compare Canada to see how we're doing? Yeah. So Canada's, there are a couple of things that you try to do when you're an analyst, such as myself.

And you're always trying to find comparables. And now this is true if you're doing bottom-up. So if you're looking at Canadian Tire, you might think of other retailers that are countrywide and that sell sort of the same type of products that have similar margins. You wouldn't compare Canadian Tire with Canadian tire with Tesla, you know, you would try to compare, you know, you wouldn't know. No, no, but you know, I, yeah, no,

and it's a similar type of thing with Canada. So, you know, population might be one way in which you sort of restrict your comparison. Wealth might be another way in which you can restrict your comparison. You know, the type of products and services that country spends most of its time, effort, and money on would be another way. You could even argue religion and culture might be one way that you actually could compare. Certainly temperature or, I mean, I know I'm getting a little esoteric, but those are things that might, you know, change. Seasonality is an important factor that you might think of. And so for Canada,

you know, things that stand out for Canada, number one is that we are a country that's relatively wealthy. So that's one way to narrow things down. Number two, we're relatively young, you know, compare our median age of Canada, which is probably in the, you know, the 40s with, you know, the median age of, let's say, Japan. And so you might compare also sort of the types of exports that we have. So for example, Japan produces zero oil, and Canada is the fourth largest producer of oil in the world. And so one of the countries I think is an important comparable is, in fact, Australia, as I think you mentioned. Another one might be New Zealand, although it's much, comparable is in fact, Australia, as I think you mentioned. Another one

might be New Zealand, although it's much, much smaller in population. So that's difficult comparable. Another one might be, you know, the UK, except, you know, their service sector is more sophisticated than ours, and they don't produce as much oil anymore. So Canada's sort of, I wouldn't say unicorn, that's way too strong. But to compare Canada to countries with, say, a shrinking population, such as Japan or Italy, is I think is just sort of misrepresentation of the facts. It would not stand up to any kind of proper analysis. To compare Canada to the US is also kind of dangerous in the sense because the US isS. is much, much larger, wealthier, more sophisticated as far as an economy, both from the export standpoint, as well as a services standpoint. But you know, the truth is, these comparables are never perfect. You're always

going to have to sort of shave off the edges here and there. But yeah, so that's sort of the thing that I think is important. We didn't mention, I didn't mention GDP per capita. Simon, would you like me to? Yeah, yeah. Talk, definitely, if you want to add some, yeah, talk about that a little bit. And then we can shift with the fun topic of inflation, CPI. Oh, yeah, for sure. You know, maybe some interest rate from the Fed as well.

Yeah, oh, for sure. I'm happy to talk about any of that stuff. So GDP, as I mentioned, is sort of the total productive capacity of a particular country. So GDP, as I mentioned, is sort of the total by the number of people that you have in an economy. And so one way that you sort of account for that is to do sort of a common size analysis. Basically, you divide the total productive capacity of an economy by the number of people who actually live there. And so what does that mean? Well, what matters is sort of when you're thinking about improving people's livelihoods and welfare is how productive each person is. And again,

averages obfuscate some kind of distributional issue, right? There's the Gini coefficient, which measures how wealth is distributed. And I think the higher Gini coefficient means that wealth is extremely unequal and lower means that it's less unequal. I might've gotten that wrong, but anyway, you get the idea. So, but in general, so what people should be looking at is sort of the improvement or not of the GDP per each individual. And so why that this has come up really the last, let's say, year or so is because Canada's top line, so total productive capacity keeps growing, but it's GDP per capita, meaning the productive capacity of each individual Canadian is basically flat. And that's a really, really important distinction. It means we've effectively

have not gotten wealthier, again, not cash money, but as sort of a broad strokes, just better off since basically 2018. And you say, Rich, how is that possible? Well, it's because we literally just have physically more warm bodies in our borders. And so if you think about each person's productive capacity times the number of people in your economy equals your GDP, let's just say broad strokes here. Well, if your productive capacity goes down, but you add loads and loads of people, you can have a situation where your GDP, your top line number actually increases, but everyone is actually worse off. And for Canadians, unfortunately, that's exactly what's happening. Is it typically, that I'm not sure, so I'll ask you, I'm sure you would know,

but is it typically inflation adjusted, these numbers? Absolutely. Very, very important point. So when you look at GDP, if your economy is, let's say, 100 and prices go up to double, your nominal GDP, so not inflation adjusted, would be 200. But there's been no real change. And I'm not sure if that's why they use that word, but it's actually quite useful in this scenario. There's been no actual change in your wealth. And again, using welfare welfare sort of a productivity output

output basically and so you absolutely have to adjust your gross domestic product by inflation and that's when i say that canada's real gdp per capita has not improved in fact i believe it's down since 2018 that's a scathing indictment on our economy. And we've got to do something about it, I think. But anyway. No, I think so too. And I definitely, towards the end, maybe we can look at some potential solutions. Absolutely. As do-it-yourself investors, we want to keep our fees low. That's why Simone and I have been using Questrade as our online broker for so many years now. Questrade is Canada's number one rated online broker by MoneySense. And with them,

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and we are better for it. When BMO ETFs reached out to work with the podcast, I honestly was not prepared for what I was about to see because the lineup of ETFs has everything I was looking for. Low fees, an incredibly robust suite and truly something for every investor. And here we are with this iconic Canadian brand in the asset management world, while folks online are regularly discussing and buying ETF tickers from asset managers in the US. Let's just look at ZEQT, for example, the BMO All Equity ETF. One single ETF, you get globally diversified equities. So easy way for Canadians to get global stock exposure with one ticker. Keeps it simple yet incredibly low cost and effective.

Very impressed with what BMO has built in their ETF business. And if you are an index investor and haven't checked out their listings, I highly recommend it. I bet you'll be as pleasantly surprised as I was that BMO, the Canadian bank is delivering these amazing ETF products. Please check out the link in the description of today's episode for full disclaimers and more information. I want to jump in too, because obviously everyone is, inflation is top of mind. CPI for Canada just came in at 4% for top line. So I just wanted to get your kind of general thoughts. And also with the Fed kind of announcing a pause on their end, but definitely a hawkish pause, I think.

That's definitely how markets seem to be interpreting it in the last couple of days. My first question is, yeah, general thoughts. And then is the Bank of Canada screwed? It's the second question, because obviously if the Fed ends up hiking or they are, I'm not sure if they're forced, but definitely if they don't, it would put weakness on the Canadian dollar

and then could put some inflationary pressure with imports into Canada. But at the other end, if they do hike, obviously we're seeing the consumer kind of, you know, a lot of pressure being put on consumers. Like that's one of the things Canadian Tire said and lots of retailers also said the same thing where consumers shifting from, you know,

non-essential to essential. So we're definitely starting to see that shift even in the US. Walmart mentioned that as well and Target too. So yeah, sorry, it's a long winded question, but just your general thoughts on all of that. Yeah, so CPI stands for Consumer Price Index. You'll note in economics and finance, everyone seems to love acronyms and I have a habit of forgetting what they mean. But CPI is one I remember. And CPI means Consumer Price Index. And what effectively that is, is a basket of goods. Now, how do you define a basket of goods

for 40 million people with difficulty? And it's often done badly. But I give the people at Stats Canada the benefit of the doubt. It's sort of, again, another thankless task that's very difficult. preferences and priorities of Canadians or consumers in general, and understanding how that changes and why. And the reason it's important to understand that is to understand number one, how government should specifically, policymakers should act. And then there's obviously knock-on effects on how non-financial corporations should act and banks and etc, etc. And so in Canada, you know, CPI, so inflation, you know, peaked around 10, I can't remember quite exactly the numbers, and has been falling because of different factors. So in your basket, as anybody will know,

you have sort of spending on goods, you have services. Within your services, you might have your dry cleaner or your transportation services costs. And within goods, you would have things like energy, clothing and apparel, you'd have durable goods, non-durable goods, food, etc. And so in Canada, what we're seeing is a situation where we're finally after, after let's say two years of much, much higher inflation than we're all used to after governments and policymakers, in my view, lied about the transitory nature of the inflation.

I either lied or didn't know what they were talking about. I'm not sure which one it is. So quote George Costanza, it's not a lie if you believe it. And I think that's a terrible excuse. I think that, and so people, just for people who may not understand, for basically throughout the pandemic and afterwards, you know, policymakers sort of in chorus, which I think makes it even worse, insisted that the inflation would be transitory.

Now, there's two problems with the word transitory. Number one, everything is transitory. Literally, the sun is transitory. In four billion years from now, there won't be a sun. And number two, by doing that, you paper over all of the really nasty things that inflation will do. And the reason high inflation is bad is because most of the time wages don't catch up to inflation. So your wage growth does not rise with inflation, which is to say wages, what you're getting paid does not rise with the increase in costs of the goods that you spend your hard-earned money on, your after-tax hard-earned money on. And so you are basically worse off. And so that's why

low inflation is paramount for, and has been, excuse me, paramount for central bankers, because it basically keeps people's purchasing power parity intact and allows businesses and governments to make forward-looking decisions, knowing that their dollars are actually going to be worth something. So, Simon, sorry, I went off a little. No, no, that's okay. And it also impacts the lowest income households the worst, right? Because, you know, food and shelter is definitely primary needs. But it's also a larger portion of their basket, which makes sense.

If you make $100 million, you're still only eating three cheeseburgers a day. Maybe that's a bad example. Are you talking personally here? No, I don't. $100 million? No, I'm getting old. I can't eat cheeseburgers anymore. I was more talking about the $100 million.

Oh, God, no. I wish. I wish. Oh, God, no, I wish, I wish. And the other way, by the way of a lower class person, you might be renting. You don't have an asset. And what that asset does is that asset is priced again in real terms. So it's often, not always, but it's generally inflation protected. It's a real asset. Again, using that word real comes up again and again when we talk about economics. So back to what's going on right now is a situation where we had inflation due to something called base effects, which is basically a fancy way of saying it's very difficult to continually rise your derivatives.

So if you think of calculus one class, your curve goes up. But in order to rise, you need to have an increasing amount of inflation. Well, and eventually the math sort of catches up with you. Your inflation starts to roll over. Now prices are still rising. They're just rising at a lower pace. So it's very important. People say inflation is coming down. Well, it's still high. It's disinflation, right? Yeah, it's called disinflation. Again, fancy dumb names that economists like to use. Yeah, sorry. No, no, it's okay. For nerds like me, we love to read about this stuff.

No, no. I mean, I'm as guilty as anyone of using that jargon, but it's true. And so what we've seen is naturally because the demand issues sort of petered out, energy prices started to slow down, and we got sort of the supply dislocations to sort of melt away, we saw a lot of these inflation stuff come down from the peaks of 10% down to sort of, I think it was 2.8% we saw. And what is going on right now in Canada specifically is because energy prices are rising, because there's so much excess demand from record population growth, which people don't like to hear, but it is absolutely true. And because of deficit spending, that's not my words. Those are the words

of the Bank of Canada, although they're more subtle than that. You have a situation where inflation, instead of returning back to the Bank of Canada's target, which is 2%, but with a 1% band, so between 1% and 3%, it's become sticky. And again, that's sort of language that we like to use, which is to say that the rate of change is not falling fast enough and is staying above that 3% range. And back to your question, Simon.on sorry i'm going on a bit which is no no that's good i think just uh context is really helpful for for people to understand and get some context about just that you know aside from just a headline number yeah so why why it puts the bank of canada in a jam which is your real question is because the bank of canada's job is basically to keep inflation between that 1% and 3%. Now, people, of course, argue whether or not central banks have any actual power.

I'm of the view that they do, and they do by raising interest rates. And why raising interest rates is powerful is because it affects people's decision-making and affects people's ability to consume, and that affects aggregate demand. Less aggregate demand, less pressures on prices, less pressure on prices, inflation falls. And so they use this lever, which is, of course, a very blunt tool, a blunt tool with lags, which who knows what the lags are. But it's their only tool. And so the situation that the Central Bank of Canada finds itself is that Canada's economy, specifically its households, are extremely levered. So we have household debt to GDP of $110 or whatever,

depending on how you're calculating or who's calculating it. Our debt is mostly mortgage debt, and that mortgage debt is short-term mortgage debt. So between, let's say, one and let's say five years, I'm just using broad strokes. And so what you're seeing is a situation where you've got two sort of fighting forces, where the central bank wants inflation to come down, but deficits are significant. wants inflation to come down, but deficits are significant. Population growth, literally just more people coming, is having an upward pressure on inflation, as well as higher energy prices. And their job is to... And so what they do, their reaction function is, okay, well, we're going to raise interest rates to combat this sticky inflation. But the problem is that

Canadians are highly levered and we're highly sensitive to the short inflation. But the problem is, is that Canadians are highly levered, and we're highly sensitive to the short end. So the short term interest rate, and that is causing a lot of pain, Simon. So they're in a jam. Well, I also I think it goes back to what we're talking about when you know, your economy is dependent two thirds on consumer spending. know your economy is dependent two-thirds on consumer spending um i mean obviously interest rates are gonna hit that spending sooner or later and i think i think the banks and i i think people in general no one really knew everyone knew there was a lag effect on the interest rate raises but no one exactly knew what it would be i think most people i what i read was like six to twelve months was kind of the the range i think now we're what I read was like six to 12 months was kind of the range.

I think now we're probably seeing might be on closer to 12 months, depending on how a lot of the debt is structured and people are feeling it. Sure. So one of the ways that we, one of the things that I really like to look at is something called the debt servicing ratio. And I've talked about this on the Looney Hour before. And what that is, is basically your household debt. And then you have that. So it could be consumer debt, it could be mortgage debt. And consumer debt, by the way, is like a credit line or a credit card or a personal loan or an auto loan or a student loan. And then mortgage is mortgage. Everybody knows that is it's household, you buy a house or condo or whatever? And then you have a debt servicing ratio, which is the amount of money out of your after-tax disposable income that you can allocate to service that debt.

And the problem with Canada is that we have way more debt than we've had in the past because we've all speculated in some way or another. I mean, I say all. I mean, most of us have speculated basically on a housing bubble. And we have higher interest rates. And so an increasing proportion of our disposable income is being allocated to interest. And the fact is, and that's hurting sales of, excuse me,

the allocation to consumption of services or goods or savings or whatever across the board. And that's what I think, you know, Canadian tire and other people are sort of signaling that this is happening. Yeah. I mean, you could just say we got high on housing. That's what it is. I mean, it's crazy. Yeah. I mean,

I, I like just a personal story. I think people may have heard me saying before, but we bought our house in Ottawa in 2019 and we got approved for a ridiculous amount, but I crunched the numbers because I'm, you know, I'm a mad nerd and i'm very conscious about

that stuff and my personal maximum or our personal maximum was actually 30 percent less wow than we were approved for because i just did some assumption my assumptions were simply what if and at that time it sounded crazy but what if rates go to five percent you know mortgage rates so not necessarily the Bank of Canada rates, because I'm like, okay, they could raise it to, you know, 3% that could lead to, let's say, in the fives or high four in terms of mortgage rates. And I just made the calculation, I wanted to be able to have a cushion, be able to invest, save, and keep our standard of life. But how many people actually had that discipline i i don't know

right yeah no i think that that's and then that's why like you know the bank of canada rightly deserves criticism and now who should give provide that criticism is i think is it is you know i think that's better enough you don't approve a politician sending letters to the central bank? I think it's on both sides, by the way. I thought that was ridiculous. I think it's, I mean, again, this is not a poll. They're trying to score political points. It's embarrassing.

It's embarrassing. Central banks, we didn't mention this. Central banks are meant to be independent technocrats. factor is vital because you can't have your politicians basically lean on central bankers because of things like hyperinflation or what have you. And so that's a conversation maybe for a different day. But the Canadian housing market is particularly nasty, what's going on now. And back to the criticism of central bank because you know in i think november of 2020 um the bank of canada's governor has told canadians to borrow because interest rates would be low for and i quote a very long time and they did and canadians you know

you know show me an incentive and i'll show you a result. And the reality is, probably for many, many Canadians, the only way you've been able to get rich, build wealth in some capacity, again, small r rich, is by in housing. And why? Because it's a levered asset and housing and interest rates went only one way. Interest rates only went down and housing only went up.

And so there are a generation of people who have not invested in businesses, but have invested in real estate. And so at the time when... And in 2020, Canada's housing was already one of the most overvalued in the world. Now, the problem with that stat though, by the way, is that it's often... It often massively skewed by two jurisdictions,

Vancouver and Toronto, everybody knows. But here's where the nasty bit came up. So in the last two years, you had a bunch of sort of smaller jurisdictions with much lower price points and on lower incomes sort of chase that dream as well. And they chase the dream because interest rates were low. And to avoid the stress test that you talked about, they often went on variable mortgages instead of pricing in a fix. So they went on a variable mortgage,

which is very, very, very sensitive, obviously, to the interest rate policy. They were offered a much larger mortgage as a result because interest rates were low. They purchased a house that they at the time could afford and interest rates went up. And that is absolutely killing people right now. And you're right, Simon, I think we haven't really seen the full brunt of that wave come through. Yeah, no, I think you're absolutely right. I know that's probably more in Steve's domain or Dan Post, who does our Canadian Real Estate Investor podcast.

But the number of mortgages that are fixed payment variable rates from, not all banks, I believe there's like three or four of them that have that. And but it's starting. It's pretty alarming. And these people will really it'll be interesting from, I guess, from a macro perspective, but obviously from the human side, you kind of feel for these people. But when their term comes up, because they have to essentially go back to that 25 year amortization or 20 years, whichever it's at, and you could see a slew of either power of sales or I think foreclosures. There's only a couple of provinces that have that system. As do-it-yourself investors, we want to keep our fees low. That's why Simone and I have

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In general, I mean, what's your thought? Like, I wasn't planning on going there, but what's your thought on Canadian banks? Because I've been following and digging into their financial data quite a bit in the last couple of months. And even going back to 2008, 2009, the loan loss provision, just as a percentage of their total loans, you know, were nowhere near close to where we were at back then. So I feel like we're going to see the banks actually ramping that up. Like we're going to see the banks actually ramping that up. And if you add in some, I don't know if you saw the news, but BMO, I believe, is going out of the loan car loan business for indirect loans. So I think there is probably some issues brewing there. So what's your general idea on like where banks are going?

And are we going to see more loan loss provisions in the coming quarters and potentially years? Yeah, banks are tricky, right? Because people have been sort of betting against banks and betting against the Canadian housing market for a long, long time. And the truth is, Canadian banks are an oligopoly. Some might say cartel that are protected by the Canadian government. And they have a license to print money. Just so Canadian listeners understand, in the US, there are 4,800 banks. Now, it's a bit of a misnomer. You probably got to have 100 banks that are enormous. And what I mean is enormous, I mean, like multiples and multiples the size of the Canadian bank. And then you've got, you know, thousand banks that are regional banks.

And then you've got a bunch of little minnows. But the point is in a country with 330 odd or 340 odd million people, you've got, let's call it 1500 banks that are of a reasonable size. And in Canada, we have 40 million people and we have six banks. And so the competition for your deposits are non-existent. And this is why when you go and take money out of the ATM, they get away with charging you $3.50, which by the way, is freaking criminal. And in the UK, for example, it's free. I don't bank with the big banks. As i just as a principal i will not pay those well offline you'll let me know who you're banking with because i would love to switch um but but just so as far as like the negativity on banks it's always important to couch to temper any

negativity on the fact that they run a cartel and so they they extract rent. So an economic rent, not a rent that you live in a house, but economic rent, e.g., they extract more money from Canadian consumers than they otherwise should or could in a properly functioning market. And that's very important. Number one. Number two is, again, we talk about this GDP thing thing if you have an enormous amount of people enter your economy you have an enormous amount of people paying these outrageous fees at the atm and so these banks which are a cartel that are protected in good faith by the canadian government it's an illegal cartel let's see it i'll maybe specify that. And they are allowed to extract way more money than they should from Canadians. So in a situation where there's more and more Canadians.

So those are two things that are very important. So yes, I think that the provisioning is going to go higher. Yes, bank earnings, I think, will come under pressure for the first time, maybe in a generation. And I think that you're right. I think that signal of the Bank of Montreal moving away from the auto sector, I think, is a really, really important one. And I think that the fact that they're pushing out amortization rates, so normally when you borrow money for a house, it's 20 years. When you push it out further, that affects their near-term cash earnings. Yes, over the length of the mortgage, they'll make more money, but over the near term, that's less cash flow. There's definitely going to be a

squeeze on earnings. And I think that for the first time, probably in living memory, they're not going to do as well as they have in the past which i think is fascinating i was going to say funny but oh no i totally agree and on the size for like for people to just kind of wrap their heads around it so out of our big six there's two banks that are g-sib so globally systemically important banks there's royal bank and td so that's how like massive and i think what there's like 30 in total g-sib across the world something like that just going on memory i've been checked in a few months but that's how big and i remember when the svb so silicon valley bank went under in march i had a look at the largest banks in the u.s and the total you know total

assets of canadian banks just to see how they compare and the total, you know, total assets of Canadian banks, just to see how they compare. And I believe five out of the six would be technically in the top 10 in the U.S. just to give like an idea of how massive our banks are. And like you said, the U.S. has like thousands of banks. So just to give a little bit of context, because yeah, our banks are for such a small country, they're massive. Yeah. I mean, the other thing, too, is like the banks generate money on churn. So what does churn mean?

It means like issuing and originating mortgages. So they get money on the way in with fees. They get money on the way out. They get money on interest. I don't mind private companies making money. That's not my beef or my point, really. My point is mortgage lending collapses, maybe the right word. And so if you're not making money on fees and the interest payments are being pushed out and or slowing um that's going to affect your earnings too and and so that's why these banks i think are going to have you know a really really interesting slash difficult time going forward

no i think you're right i mean one thing i've been keeping an eye on for banks is their interest margins yeah the overall interest margins have been not like alarming rate. Obviously, it's just there's, what, hundreds or thousands of metrics to look at, especially when you start looking at their supplemental financial information. They really drill down and you can probably look at that for days. But most banks, it's definitely slowing down a little bit. I don't think it's anything alarming right now, but something to keep an eye on for people that are looking at banks. I'm surprised by that.

So net interest margins basically is what you lend versus what you borrow. And banks, we'd say, do banks borrow money? Absolutely. You, as a consumer, lend them money. You say, Rich, I'm not lending banks money. you as a consumer lend the money say rich how i'm not lending banks money every time you deposit money into a bank you lend them money that is effectively the transaction being taken place and they compensate you with a return on your savings account and they take your money and they effectively lever it up and they lend it out and they get

an interest rate, let's say on the mortgage, and they pay you your interest rate on deposits. And the spread, broad strokes here, is the net interest margin. I am shocked that interest margins are not going higher because banks are not handing over the five and a quarter, Banks are not handing over the 5.25% overnight rate to depositors. My bank, I'm not going to name the name, pays me 1.7% on my savings account. I mean, that's actually for a big bank. That's probably pretty good. But short-term overnight interest rates at the bank of canada are five percent so yeah so to me so again the reason banks in canada are able to do this because there's not enough competition because in america

your short-term interest you're short you're you're the lent member you're when you deposit money you're lending money to the bank they'll pay you four and a half, five percent. And so I'm surprised that the net interest margins aren't shooting higher, really, in a situation where they're not at all passing those interests to the consumer. I mean, it could be. I know in March and April, I know in the US, they were starting to see a shift. People were freaking out with regional banks. So they were shifting their deposit there to either some of the G-SIB of their own, JP Morgans and all the big banks over in the US and also to money market funds because it's an option to get more yield. And that's one thing I've been keeping an eye on because National Bank has a really great report. They come in every

month. It's like ETF inflows and outflows. They do it for Canada. They do it for the US. Oh, check it out. Yeah, it's a really good report. I can send you the link afterwards if you'd like, but I usually will do a segment on it every couple of months. Just I'm interested in seeing what people are doing. Are they going more in fixed income? And then you drill down what kind of fixed income. And that's something I'm sure some people, I mean, I've been pretty vocal about that is, you know, look at your options, because yes, there's not necessarily CDIC insured everywhere. If you go to money market funds, it won't be. And some people like to have that safety. But at the same time, one of the ones I'm a big fan of is, you know, there's an ETF, it's US dollar, it's one to three months treasury bills,

and it pays like 5.25%. It's backed by the Fed, right, by the US government. So that's one of the ones where there are options. And there's also ETFs where you can put your money and it gives you like, you know, their high interest savings ETF that give you like 5 percent obviously not cdic insured but they're bagged by deposit at the big banks but so this is why i'm particularly vexed with the regulator in canada because it's in a sense it's fine to have one or two companies for example in quebec when you buy electricity it's one company hydro que, because it's a natural monopoly, but it is super highly regulated and the regulations have teeth. So Hydro-Quebec cannot just price you a million dollars a kilowatt hour and say, screw you, we're the only people in town and you either buy electricity from us or you go, you basically die. And so the regulators, the natural monopoly, and so the regulator has teeth

and then the consumer basically lives in a world where he's at the mercy of the regulator, but hopefully the regulator is doing their job. In Canada, it's the opposite. We have an oligopoly and a regulator that does not at all care about the consumer. And as a function of that, those higher interest rates are not passed along to the consumer. We pay exorbitant amount of fees that are outrageous in a world where everything should be automated. should be automated. And you're in a situation where... And the banks make lots of money. And again, the regulator just sits on their hands. And so in my view, I don't think Canadian consumers should have to go find an ETF.

I think you say, I mean, you make an excellent point, Simon, but not to sound, not to be a total jerk, but I just don't think most people think that way. I think people... I know. You're right. You're absolutely right. And in this very specific stance, normally in different... I would agree with you in many, many different respects. But in this specific stance, when it comes to banking,

I think people see it as a utility. And I think people, when they deposit their cash, especially in a world where there's only four options, they shouldn't have to chase them. They should just be passed on what they're owed, which is that short-term rate in my view. But maybe I'm wrong. No, no, I totally, I mean, I agree for me, like for a lot of people, I think just the switching costs in terms of like the time that's required it's a pain you have to yeah i think some of the options that are available um are definitely you know you can do most of it online but i've noticed and i was talking with my co-hosts on that is just like the big banks oh my god they make things like painful for like running a business it's so painful like

there's stuff you have to go in person to go and sign the documents. It's ridiculous how much red tape and... There's no incentive. They have no incentive to change because there's zero competition. In the UK, there's something called open banking. What open banking is, is effectively

it allows a third party to access all of the data that the banks in the UK have effectively. And by doing that, what it does is it totally shakes up the industry because it allows, for example, competition, either in the form of credit cards that can use that information to allocate, to do risk assessments on individuals. It also forces banks to, if you want to switch, you can basically switch for free. They do all of the work because the regulator there, FCA, is probably one of the best financial market regulators in the world. And they have teeth. They genuinely care about the consumers.

I'm going to say it again. The regulator not care at all about the canadian consumer when it comes to financial markets and banking um i know that's a strong point but i think everyone who takes ten dollars out of their atm will agree with me yeah i mean even if you take osfi right there which is the office of superintendent there you go of canada i mean i know them especially from the pension front because they do regulate federally legislated pensions so that's where i know them the best but definitely obviously i know they regulate banks and i mean their mandate is really to make sure that the banks are in good financial you know situation right they don't go under it's not really to protect the consumer

no it's definitely not but anyway sorry we went on a little bit too long for that but i'm sure you had no i did have one last question because we're almost 50 minutes in um so you know what is the two percent or the one to three percent obviously ban of inflation? Or let's just say 2% to keep it simple, the average or the middle point of that. Is it realistic long term, in your opinion? I know the central banks have been steadfast on that, at least in Canada and the US with the Fed, that it's still 2%, our target is still that. But is it realistic? that, you know, it's still 2%, our target is still that, but is it realistic? And do you think at some point in the next maybe five years, they'll have to switch and say, maybe now it's two to 4% with like the, you know, middle being 3%. I'm just kind of wondering, because it seems

like, I don't know, a hopeful thing. I just don't know if it's really achievable. And like second question on that, like what impact would it have to trying to hit that 2% target on sovereign debt, especially in Canada and the US? I mean, we're seeing record, not record, but high deficits in Canada. I think it's around 40 billion that's projected for this year and 1.5 trillion in the US, I think in big part because of the Inflation Reduction Act, which I still scratch my head every time I hear that. It's like the biggest misnomer ever though. Yeah, I know. I know. It's just hilarious what they named. But yeah, just to go back, is it 2% inflation realistic or do you think they'll have to pivot and go for 3%?

I mean, okay, so if I may, so, you know, different central banks have different mandates. In the US, for example, there's a dual mandate. So it's full employment, which no one really knows what that means. As full as possible, I guess. Full employment meaning low employment i guess um i mean academics wouldn't say that they know exactly what that means but anyways um and then inflation i don't i think it's just stable inflation i don't even think the u.s technically has a two percent mandate um unlike in the u and unlike the ecb or in the uk or in canada where they have explicit numbers

attached to those inflation target i don't actually believe the u.s does but anyway where it came from the two i do yeah i was about to say you know that that i don't know yeah yeah so actually it came actually from the reserve bank of new zealand okay that's what i thought i had read but i wasn't sure yeah yeah so in i think in the 90s, the Reserve Bank of New Zealand was sort of the first central bank to sort of throw out this idea. Well, sorry, let me rephrase that. They were the first people to sort of take that idea very serious and basically encode it in their, let's say, company or organizational ethos. Because this idea of keeping inflation low or managing inflation using interest rates is very, very old. It's an old idea.

I'm not exactly sure how old, but it is old. But the Reserve Bank of New Zealand, I would argue, maybe I'm wrong and someone will correct this, but I think they're the first people to say, we're putting it on the books and this is our job and this is what we're going to try to aim for. And then sort of everyone sort of followed suit. I think they did in 1994. I think they did in 1994 and then everybody sort of followed through. And the reason they do this is this idea, again, I alluded to this earlier, which is if households, companies, governments, banks have a relatively clear idea of what inflation will be,

they can better make decisions pertaining to investment, savings, whatever, capital allocation. And interest rates can follow suit from that and there'll be less room and less opportunity for misallocations of investment. Now, normally you want your inflation to be below your interest rates. Oh, sorry, that's right.

So you want to have um so you want to have a real positive real interest rates meaning that your your money costs something when you adjust for inflation does that make sense yeah and so and and why so that because in the opposite is you get a situation where you're effectively, I know this in theory, are being paid to borrow, which is always dangerous, which is causing speculative bubbles like we've seen in Canada and in Germany and in Ireland and in Spain and the US. Show me a negative real interest rate and I'll show you a real estate bubble effectively. But anyway, so your question is like, do I think this is a real estate? I actually don't think it's realistic, but maybe not for the reason you might think, which is I think there's way too much debt, government debt, and zero political appetite to raise taxes.

And you say, of course, Richard, they're raising taxes all the time, the carbon tax, blah, blah, blah, not on the right people. And so, and who are, what do I mean by the right people? I mean, old people, old people. Well, they could cut spending. That would be an option, but there's not a lot of appetite for that. Not a vote winner. So austerity has zero, in my view, I know we're getting into the realm of politics, but I think there's absolutely zero appetite for austerity, which is to say low cutting spending. And there's zero appetite to raise taxes on the richest cohort in our society, which is the baby boomers, people born from 1946 to 1964, who have a lion's share of the wealth in this country and most developed countries. Probably our parents, I would say.

That's right. My parents are baby boomers, but I'm assuming I think you're about the same age as me. That's right. My mom is 73, so she won't really appreciate me telling the world, the government, that they should raise taxes on her. She would say that she's paid enough taxes and she might be right.

And then the other third thing is it's basically going to be impossible to raise taxes on a shrinking labor force. So everyone who's not born between 1946 and 1964, well, there's a whole lot less of them. And so those are the three options. Those are the options. We either cut spending, no one wants to do that. We either raise taxes on baby boomers, no one wants to do that. Or we raise taxes on a shrinking labor force, which is,

in my view, cruel, but also not going to cut it because the labor force is shrinking. And so as a function, and then the hang up is that we have all of this debt, right? We have debt to GDP. That's very high everywhere. And so in my view, the only way that you can effectively get rid of that debt is by inflating it away. And so the real returns on your bonds, so the returns that you get for holding those bonds for lending money to the government will be negative. And the way that you basically ice that is you deflate that debt away. So you keep inflation high. And now they'll say that they want to bring inflation back to target, but I think that's a bunch of baloney.

I think that they understand that the only way any of this rebalancing occurs is through inflation. And there is another way you could do it, which is basically you default, which is to basically default, which is to say, screw you, investors, I'm not going to pay you back. And there's another way,

which is you do a sort of debt for equity swap, which is you basically sell assets. So Hydro-Quebec sells the dam and they pay to investors and they use that cash to pay down the debt, which is, I don't think, going to happen in a country like Canada. But,

and so, so that's the situation. And so, you know, we're in. And so, and then by the way, this is as old as time.

Oh yeah. Right. Yeah. This idea that you deflate debt away as old time. You say, Richard, how is, what do you mean?

That's not possible. It's like, yeah, you devalue the currency. And I'm, I love history history i'm obsessed basically with history and well ray dalio has some great books that looks about like perfect you know that goes well into detail i love his books so yeah you know i was going to reference

nero i was going to reference emperor nero who basically used to shave shave the edges off the coins right in rome it used to be silver coins you shave a bunch of edges you get an and then you melt it down and you get another coin and each of the other coins is worth a little bit less and and basically effectively you you devalue the debt by devaluing the currency and to answer your question sorry simon i went on and on but i think no i don't think i think they'll say that they want to keep the target but i don don't think anybody has the, let's say, the intestinal fortitude to get us there. Yeah. And then if we enter a recession, right, I think you've made a really good point is we enter a recession. Clearly, people lose their jobs during the recession. That's just how it goes. And then you can make

a case that tax receipts or tax revenue from the government would also go down in a recession. So I don't know how it's going to play out. Maybe the last last question. I feel like it looks like a lot of data like it will know after the fact. But I have a strong suspicion that we are in a recession right now. We just won't know until maybe a couple of months or maybe probably early 2024, I would say. Do you agree, disagree with that? Just kind of on a last note.

Totally agree. I think we've been in a recession for a year and people say, Rich, that's strong. It's like, well, yeah, there's no... So recession is both usually a combination of both a contraction in GDP. People say it's two quarters, but that's completely arbitrary. So let's use that because whatever, everybody agrees with that, but is totally arbitrary. So two quarter contraction in GDP, as well as some kind of decline in employment. Now, I would say Canada is a bit different because we have this massive influx of people.

And a year ago, no one wanted to talk about it. Now everybody's talking about it. So maybe it's a contrarian indicator that everybody's talking about it. But the point is, is that if you just have literally more people on your shores, your GDP goes up. But that hides the malaise, which is what I think you're sort of identifying, which is everyone in Canada has gotten poorer. And it's not a one-off. It's now, I think you're sort of identifying, which is everyone in Canada has gotten poorer. And it's not just one, it's not a one-off. It's now, I think, five out of the last six quarters or four out of the last, you know, whatever. And so you see the line on the chart is quite clear.

Like you're either flat or down. And so in my view, you know, we haven't had any, you you know contraction in the labor market but again i think that's kind of hiding the fact that i agree with you simon i think we we have been and are in a recession and it's it's you know may i just like end with one thing it's like how do we get out of it and one of the ways we get out of it is we sort of lean in to what Canada does well, in my view, which of course no one wants to hear in Ottawa, which is the fact that we have this amazing, huge country full of natural resources, and we can exploit those in an ethical and environmentally sustainable way. sustainable way. And the other way we could do it is by investing in research and development, which we have an absolutely abysmal record of. So how do you calculate that, which is research and development spending as a percentage of GDP? Our number is maybe 1.6%. Compare that with the

US, which is 3.4, whatever the number is. Compare that with Israel and South Korea, which is in the fives. Oh, wow. Okay. I didn't know that. Yeah. I'm not saying we should be Israel and South Korea, which is in the fives. Oh, wow. Okay. I didn't know that. Yeah. I'm not saying we should be Israel and South Korea. They don't have any oil. They're their own thing. But surely, lifting it off a 25-year low is a good place to start. And how do you do that? You do make tax incentives.

You give companies breaks and incentives to come here. And we have all the universities in the world. We've got loads of space. The idea that our research and development spending is at a 25-year low and in line with third world countries, I think, is an embarrassment. And absolutely a way we can improve our productivity and the welfare of Canadians, ultimately. Yeah, I mean, I think that was a great point to wrap it up because honest, I think there is, you know,

people might say, Oh, it's a lot of doom and gloom, but there's definitely hope. And there's things I think, like you just said, we can do to make a better future. I mean, for us,

for younger generations, I mean, my daughter who's one year old, obviously I want her to, to be able to make a good living and have a good life. But I think that's a good way to end it here. Honestly, I feel like we could have gone on for another couple hours because there's a lot of questions I want to ask you. So maybe at some point, you know, you can come back on the podcast and, you know, we can continue the discussion.

I'm sure there's going to be tons of new macro data out that you'll want to be touching on. Last thing, where can people find you? I know there's the Looney Hour, there's other spots. Right. So I used to be very active on Twitter. I can't really do that anymore, unfortunately, which is a shame because I really enjoyed that. But, you know, if you're an institutional investor and you're interested in trading with us or subscribing to our research, you can look us up at PGM Global in the Google machine. You can listen to us every week on Fridays on Looney Hour, which I would really encourage you to do. And for now, I think that that's it until I write a book or something. I don't know. Okay.

Well, thanks a lot, Rich. Yeah. Thank you so much, Simon. I really appreciate as you can tell i i love this shit man it's fun it's i'm i'm really grateful that i can get to do this for a living i'm you know just learning basically and and eating humble pie every day when you get stuff wrong is to me um quite a privilege and i really appreciate the time that you've given me today so thank you well thanks for coming on. And I'm sure

you can tell I love this stuff too. So I have work to do, but I totally could have gone on. Yeah, we'll definitely try to do this again. So thanks a lot, Rish. All right. Cheers. The Canadian Investor Podcast should not be taken as investment or financial advice. Brayden and Simone may own securities or assets mentioned on this podcast. Always make sure to do your own research and due diligence before making investment or financial decisions.